Why is there concern about the growing income gap, and is there an ideal level?

Question

I was listening to NPR this morning about the growing income gap between rich and middle class and it got me thinking about how people's incomes would be distributed in a simple, perfect world, where everyone starts with the same income and their income has an equal chance of increasing or decreasing a certain percentage every year. The fact that incomes are bounded below by 0 and not bounded above indicates that there will be a steadily increasing "tail" of ever-more wealthy individuals who represent less and less of the population, thereby increasing the income gap even though there is, by construction, no bias or favortism in the system. The income distribution would follow a version of Geometric Brownian Motion without drift.

Now, I know that this model is nowhere close to a realistic economic model; however, it serves to point out that income inequality can arise even without favortism for a subset of the population. I am not saying that this is the case, just that inequality is not required.

Therefore, why is there so much concern about the income gap as opposed to simply the income level/purchasing power of lower and middle income citizens?

Is there some ideal level of inequality in a healthy economy?

Answer 1

First and foremost, the best measure of income inequality is widely considered to be the Gini Coefficient (also called the Gini Ratio or the Gini Index), a ratio that approximates the spread of wealth throughout a population. A Gini Coefficient of 1 would suggest that 100% of the wealth was held by a single individual, a coefficient of 0 would suggest that every member of the population held exactly the same amount of wealth.

Secondly, the Economist ran a series of articles here from which this post will be summarizing. The articles are well-written, and even if they reflect a European bias, I personally find the points rather compelling. Some recommended reading in any event would be:

1. The article For Richer, For Poorer introduces a Special Report, giving a better introduction to the Gini Ratio, and showing current level of income disparities.

2. The article Like Father, Like Son uses good statistical analysis to introduce and support the concept of 'Opportunitity Equality,' an idea that suggests that there is in fact a correlation between the wealth of families and their successful outcomes.

3. For some more nuance, Freakonomics recently had a podcast about the Georgia Land Lottery which did a really good job of debunking the idea that money alone alone radically changes the prospects of the poor, although the focus of the Freakonomics podcast was more long term.

4. Finally, the article As you were points out some traditional problems associated with and solutions to income inequality.

At a very high level, the challenges associated with a grossly skewed distribution of wealth are these:

1. Highly unequal outcomes lead to popular discontent. The Revolutions of 1848 in Germany, the rise of the French state, and the near republicization of the United Kingdom all the 1840 - 1870 time frame highlight that an increasingly unequal distribution of income will make a country less stable. (Note, I am suggesting a trend over time, however, and not an absolute level.) The struggle between the "haves" and the "have nots" is frustrating to people, even if the actual reasons are or are not justified.

2. Highly unequal outcomes may skew the incentive for the underprivileged to innovate. While the experience is hard to quantify in statistical terms, the theory states that if innovators are unconvinced that their innovations will not be rewarded, the incentive to bring new products to market or services to consumers will be eroded, and the economy as a whole will suffer.

3. Wealth itself is relative. Thus, even if all parties are increasing in wealth, if a segment is receiving more wealth than others, the parties whose wealth is increasing at a slower rate will perceive it as "falling behind." At a very basic level, consider the simple notion that the American poor is fat, whereas the emerging world's poor are thin. In the United States, there is some evidence that the poor have less access to the healtiest of foods, but around the world, it is often the case that the poor simply lack access to enough food altogether. Even within the United States, the notion of poverty is not static over time..

4. Highly unequal incomes are repugnant morally to a certain percentage of the population. As a pastor, for example, I sensitive to the plight of the poor (not unlike this guy or hopefully even this guy) because my sacred scripture tells me so. (Admittedly, sometimes it makes it hard for me to choose between a fiscal policy I despise and a moral agenda I find bankrupt, but I digress.)

5. Studies have shown (see above) that wealthier families, on average, tend to stay wealthy, and vice versa. The 'American Dream' on the other hand, wants to suggest that one's success is not inherited, but rather a function of the effort 'you' put into it. Thus, a lack of social mobility is inherently antithetical to the national narrative.

6. Educationally speaking, the 'Tyranny of the meritocracy' is also something to consider. Historically, the existence of a perennially perpetuated upper class in feudal societies was seen as a corrupting influence and its generational continuity (heredity monarchs, I'm looking at you!) is often considered a societal bad. The idea of the 'Bad King John' or the fat knight is a caricature to be sure, but one that resonates. What is at least up for debate, however, is whether or not a system that continues to perpetuate the same families but called a 'meritocracy'is sufficiently different to avoid the discontentment,

In any event, however, there is a tradeoff that should be understood in structly utilitarian terms. Too much inequality removes the incentive for work. Too little provides a reward. As such, it is probably best to think inequality not as an evil in an of itself, but rather a dangerous thing when taken to either extreme.

Answer 2

There are several problems with inequality, but I can recall three at this moment.

On a more idealistic side we have the principles that state that all men are equal. If we take this literally then everybody should make the same money per hour, because the time of a person could not be worth more or less than the time of any other person. Please note the strong connection between time, lifetime and life. While not everybody agrees on this, specially in the USA, it's still perceived that some balance should exist.

On a more pragmatic side we have the stability of the system. If there are many people with nothing to lose, that's a risk for a revolution. If there are many people with little economic power but great firearm power, that's a risk. And so on. In short, the point is to have some balance between the economic power that some people may accumulate and the power of other shorts that some other people may accumulate, because if there is no balance then there will be redistribution, which can be pacific or violent.

On the economic side we have that the average of the economy is moved by the average Joe. Sure there may be some people eating caviar every day. But certainly the weight of beef is going to be greater for the economy, in the USA, and in a global level I'd bet on rice (although I have no data). Inequality means that some people are doing really great (good for them) but some people are not doing so great, and that is a problem for the economy, because those people that are not doing so well may be most of the population, they may decide not to use new services/products (stagnation) or even stop using services they were using (collapse). Inequality evidences that those that are not doing so well should probably be able to do better under somewhat different circumstances.

If you think I should elaborate more on something please let me know, sometimes I simply don't know when to stop.

PD: I forgot. There is no ideal level, the point is simply to have some balance. Something that according to the previous points:

• People can accept as fair, or as a compromise solution.
• Is sustainable (very related with what can people accept).
• Allows the economy to continue running (very related with sustainability).

Answer 3

I would say the reason it has become a hot debate is because of the leading theories on the causality between inequality and outcomes. When you cover the basics of income and wealth inequality you may or may not care or consider the consequences. It is when you start discussing things such as generational mobility, racial inequality, neighborhood-effect and the growing gaps in educational attainment that you begin to see the consequences of inequality that the news doesn't often cover.

Not saying EVERY news station, because The Economist will from time to time introduce its readers on these issues.